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Investment columnist for the NZ Herald

Brian Gaynor: Potential problems in NZX's high level of foreign investment

More KiwiSaver money than the 10% currently invested needs to be put into listed NZ equities
Air NZ is the biggest shareholder of ailing Virgin Australia. Photo / Getty
Air NZ is the biggest shareholder of ailing Virgin Australia. Photo / Getty

Goldman Sachs' latest NZX Ownership Survey shows that overseas interest in the New Zealand sharemarket has remained static at 33 per cent over the past 12 months. This is well below the 61 per cent foreign ownership peak in 1997.

The first NZX Ownership Survey was conducted in 1989 by the former stockbroker Doyle Paterson Brown. It showed that domestic retail investors owned 44 per cent of the market while offshore investors accounted for only 19 per cent.

It is estimated that retail investors owned over 60 per cent of the market before the October 1987 market crash.

New Zealanders bailed out of equities after the '87 meltdown and overseas investors scooped up low- priced New Zealand shares. As a consequence, offshore ownership of the NZX surged from an estimated 10 per cent in mid-1987 to 19 per cent in 1989 and 61 per cent in 1997.

These overseas investors were managed funds and overseas-based companies. The latter included companies with strategic stakes in Telecom, Air New Zealand, Tranz Rail, Carter Holt Harvey, Wilson & Horton, Dominion Breweries, Lion Nathan and a number of other major New Zealand corporates.

There was a large amount of strategic ownership activity in the late 1990s and early 2000s with Telecom acquiring a stake in Independent Newspapers and the latter purchasing an interest in Sky Network Television. Consumer trusts also had significant stakes in listed electricity companies.

Meanwhile, a large number of listed companies were fully acquired by offshore interests. These included Fletcher Challenge Energy, Fletcher Energy Forests, Frucor Beverages, Lion Nathan, Montana Group and Waste Management.

Overseas-based managed funds now own 26 per cent of NZX companies, according to Goldman Sachs' latest survey, compared with 29 per cent in 1995. Domestic managed funds have increased their ownership of NZX companies from 13 per cent to 22 per cent over the same period, mainly because of the introduction of the Portfolio Investment Entity (PIE) regime and KiwiSaver.

Meanwhile, NZ strategic stakes have nudged up slightly in recent years, mainly because of the Government's controlling stakes in the newly listed electricity generators, Mighty River Power, Meridian Energy and Genesis Energy.

Forsyth Barr has collected similar NZX data since 2004, mainly in terms of the involvement of overseas managed funds in this country.

These figures show that offshore managed funds now own 44 per cent of the NZX compared with Goldman Sachs' 26 per cent figure. The difference between the two figures is because Goldman Sachs data is based on the total value of all listed companies whereas the Forsyth Barr figures are a percentage of the market's free float.

The free float is the value of all listed companies after deducting large strategic stakes. Strategic stakes include the Crown's holding in the electricity companies and the local regional council's holding in Port of Tauranga.

The Goldman Sachs and Forsyth Barr overseas institutional ownership figures are essentially the same when their different methodologies are taken into account.

The data gives a clear message that foreign investors have a soft spot for New Zealand, mainly because of our relatively low volatility and high dividend yields, whereas New Zealand investors have a strong bias for riskier offshore markets.

The NZX was also relatively cheap compared with other sharemarkets in the past but this is definitely not the situation today.

The New Zealand sharemarket has one of the highest overseas ownership rates in the developed world while KiwiSaver funds have only 10 per cent of total assets invested in domestic equities. This compares to 41 per cent of Australian superannuation funds invested in domestic Australian equities.

No matter which way we look at it - either that overseas managed funds own 26 per cent of our total sharemarket or 44 per cent of the market's free float - the NZX has a very high level of overseas managed funds ownership.

This has potential drawbacks for the NZX because long-term offshore money reduces the liquidity of our market and this short-term money could sell out if our listed companies fail to meet the expectations of offshore managed funds.

One of the solutions to this issue is to have more listed New Zealand entities and a higher percentage of KiwiSaver money invested in NZX listed companies.

AirlinesThe battle for the Australian skies has become more interesting with Abu Dhabi-based Etihad Airways' decision to raise its stake in Virgin Australia from 22.9 per cent to 24.2 per cent.

Virgin Australia's major shareholders are Air New Zealand 25.9 per cent, Etihad 24.2 per cent, Singapore Airlines 22.8 per cent and Sir Richard Branson's Virgin Group 10 per cent.

The Australian company was established in November 1999 after securing US$10 million of equity from Virgin Group. Virgin Australia was the fourth domestic Australian carrier after Qantas, Ansett and Impulse.

Ansett, which was 100 per cent owned by Air New Zealand, went bust in September 2001 and Impulse was acquired by Qantas.

In 2003, Virgin had an IPO at A$2.25 a share giving it a market value of A$2.3 billion. It listed on the ASX on December 8, 2003, with then major shareholders Patrick Corporation 46 per cent and Virgin Group 25 per cent. In 2004, Virgin launched Pacific Blue, a New Zealand-based leisure-focused airline offering flights between Australia, New Zealand, the Cook Islands, Fiji, Tonga and Vanuatu.

In 2007, the carrier established a New Zealand domestic service but this operation was shut down in October 2010.

Virgin Australia was badly impacted by the global financial crisis and was forced to raise new equity via a one rights issue at 50c a share in July 2009 and a five for 14 offer at 38c in November 2013.

The carrier hasn't paid a dividend since February 2008 and now has a sharemarket value of A$1.7 billion.

Air New Zealand's code sharing alliance with Virgin Australia, together with its shareholding in the ASX company, are particularly important because of the carrier's disastrous investment in Ansett 15 years ago.

Chief executive Christopher Luxon emphasised the importance of the Virgin Australia involvement at the company's 2014 annual meeting when he told shareholders that "customers are increasingly benefiting from being able to seamlessly connect from regional New Zealand to regional Australia and everywhere in between as a result of the Virgin Australia alliance."

The problem with Virgin Australia is that it reported a loss of A$356 million for the June 2014 year compared with a loss of A$98 million for the previous year.

The good news is that lower oil prices are giving the airline industry a big boost. But the bad news is that analysts are forecasting another loss for Virgin Australia for the current year, albeit significantly lower than last year, and the airline industry is incredibly volatile.

The Australasian airline sector has had a huge number of failures over the past few decades with the Crown having to rescue Air NZ in 2001 with an $885 million capital injection.

The NZ Government has proved Warren Buffett wrong as far as the perils of investing in airline companies is concerned.

The Crown's 52 per cent stake is now worth $1.5 billion - it realised $365 million from the sale of Air NZ shares in 2013 and has received substantial dividends from the national carrier.

To be fair to Buffett, he also said timing is everything and the NZ Government's timing as far as its Air New Zealand investment is concerned has been superb - both in terms of the financial rewards and huge contribution the carrier continues to make to the country.


Disclosure of interests: Brian Gaynor is an executive director of Milford Asset Management which holds shares in Air New Zealand, Qantas and Virgin Australia on behalf of clients.

- NZ Herald

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Investment columnist for the NZ Herald

Brian Gaynor has written a weekly investment column for the Weekend Herald since April 1997. He has a particular passion for the NZX and its regulation. He has experienced - and suffered through - the non-regulated period prior to the establishment of the Securities Commission in 1978 and the Commission’s weak stewardship until it was replaced by the FMA in 2011. He is also a Portfolio Manager at Milford Asset Management.

Read more by Brian Gaynor

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